Here’s why the stock market correction isn’t over yet

AnoraMahmudova

The U.S. stock market’s more-than-10% drop over the course of a few days has a lot of investors wondering if the worst is over.

Analysts who had previously sounded warnings over a potential pullback inclined to say there is likely more pain in store over the next several weeks.

James Abate, chief investment officer at Centre Asset Management LLC, has been concerned about valuations and profit margins for the past six months and at had previously warned that a sizable correction could be in the offing.

“Our script is playing out and we feel good for having hedged for such a downturn,” Abate said.

“The best-case scenario is that we trade sideways from this point for some time. But we expect markets to decline further as there is simply no catalyst that would take the markets higher. Historically, it would be the Fed easing, but the Fed is out of bullets and has no additional liquidity,” Abate said.

“We put a 20%-25% probability for this correction to morph into a bear market, but a trigger for that would be a scenario where some financial institutions fails,” he said. A bear market is often described as a decline of at least 20% from market highs.

The S&P 500
SPX, +0.01%
rebounded on Wednesday, rallying 3.9% to 1,940.51, breaking a six-day-long selloff that sent the benchmark index into a correction territory, which is defined as a fall of 10% or more from the previous peak.

“Valuations need to come to the levels that reflect this environment, and I think we have some ways to go. It is time to tighten seat belts, as it’s going to stay volatile for some time, because we do not have definitive answers to the China, Fed and earnings questions,” Forrest said.

Brad McMillan, chief investment officer at Commonwealth Financial Network, thinks stocks will likely be higher in 12 months than they are today. But in the very short-term, he expects the correction to continue.

“Arguably, the stock market was overvalued, so the correction was overdue. But the slide has cracked confidence and it takes time to reassemble this picture,” McMillan said.

Lance Roberts, portfolio manager at STA Wealth Management, had also written about an impending correction.

He offered several reasons why the pullback could turn into a bear market.

On a fundamental basis, he cites downward revisions to economic forecasts as well as the downward slope of U.S. economic growth and cyclically-adjusted valuation measures.

On a technical basis, Roberts uses less-used moving averages to show market behavior. When the two-week moving average crosses the one-year moving average markets are headed for a much sharper decline than a correction (see chart below), unless there is a Fed intervention, as happened in 2011, he wrote in a blog post.

Indeed, until and unless volatility dies down, markets are likely to gyrate further. The implied volatility on the S&P 500, as measured by the CBOE volatility index
VIX, -2.15%
has remained at about 30 for the past four trading sessions. In the short-term, this means sharp swings are possible in both directions.

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